nep-mon New Economics Papers
on Monetary Economics
Issue of 2019‒09‒30
thirty-two papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. The impact of quantitative easing on bank loan supply and monetary policy implementation in the euro area By Horst, Maximilian; Neyer, Ulrike
  2. Russia’s Monetary Policy in 2018 By Bozhechkova Alexandra; Kiyutsevskaya Anna; Trunin Pavel; Knobel Alexander
  3. Monetary Policy and Heterogeneity: An Analytical Framework By Florin Bilbiie
  4. Expectations formation, sticky prices, and the ZLB By Bersson, Betsy; Hürtgen, Patrick; Paustian, Matthias
  5. Hitting the Elusive Inflation Target By Francesco Bianchi; Leonardo Melosi; Matthias Rottner
  6. The Friedman Rule in the Laboratory By John Duffy; Daniela Puzzello
  7. Does Informality facilitate Inflation Stability? By Enrique Alberola; Carlos Urrutia
  8. Animal spirits, risk premia and monetary policy at the zero lower bound By Christian R. Proaño; Benjamin Lojak
  9. Asset Liquidity in Monetary Theory and Finance: A Unified Approach By Athanasios Geromichalos; Kuk Mo Jung; Seungduck Lee; Dillon Carlos
  10. A Liquidity-Based Resolution of the Uncovered Interest Parity Puzzle By Seungduck Lee; Kuk Mo Jung
  11. How Large is the Demand for Money at the ZLB? Evidence from Japan By Tsutomu Watanabe; Tomoyoshi Yabu
  12. Deviating from Perfect Foresight but not from Theoretical Consistency: The Behavior of Inflation Expectations in Brazil By Leilane de Freitas Rocha Cambara; Roberto Meurer, Gilberto Tadeu Lima
  13. Consumers' Price Beliefs, Central Bank Communication, and Inflation Dynamics By Kosuke Aoki; Hibiki Ichiue; Tatsushi Okuda
  14. Riders on the Storm By Òscar Jordà; Alan M. Taylor
  15. Puzzling Exchange Rate Dynamics and Delayed Portfolio Adjustment By Philippe Bacchetta; Eric van Wincoop
  16. Monetary Policy and Efficiency in Over-the-Counter Financial Trade By Athanasios Geromichalos; Kuk Mo Jung
  17. Liquidity Deflation and Liquidity Trap under Flexible Prices: Some Microfoundations and Implications By Guillermo A. Calvo
  18. The Central Bank Governor and Interest Rate Setting by Committee By Emile van Ommeren; Giulia Piccillo
  19. Modelling Opportunity Cost Effects in Money Demand due to Openness By Sophie van Huellen; Duo Qin; Shan Lu; Huiwen Wang; Qingchao Wang; Thanos Moraitis
  20. Elections, Heterogeneity of Central Bankers and Inflationary Pressure: the case for staggered terms for the president and the central banker By Maurício S. Bugarin; Fabia A. de Carvalho
  21. Optimal Monetary Policy for the Masses By James Bullard; Riccardo DiCecio
  22. Uncertainty and Housing in a New Keynesian Monetary Model with Agency Costs By Victor Dorofeenko; Gabriel Lee; Kevin Salyer; Johannes Strobel
  23. Inflation, Output Growth and their Uncertainties: A Multivariate GARCH-M Modeling Evidence for Nigeria By Perekunah B. Eregha; Arcade Ndoricimpa
  24. The Long-Run Effects of Monetary Policy By Oscar Jorda; Alan Taylor; Sanjay Singh
  25. How to Improve Inflation Forecasting in Canada By Troy D Matheson
  26. Does the Cost of Private Debt Respond to Monetary Policy? Heteroskedasticity-Based Identification in a Model with Regimes By Massimo Guidolin; Manuela Pedio
  27. Australian Money Market Divergence: Arbitrage Opportunity or Illusion? By Belinda Cheung; Sebastien Printant
  28. How Large is the Demand for Money at the ZLB? Evidence from Japan By Tsutomu Watanabe; Tomoyoshi Yabu
  29. Equity Markets and Monetary Policy By Xing Guo; Pablo Ottonello; Toni Whited
  30. Modelling yields at the lower bound through regime shifts By Peter Hördahl; Oreste Tristani
  31. Price trends over the product life cycle and the optimal inflation target By Adam, Klaus; Weber, Henning
  32. The Primary Cause of European Inflation in 1500-1700: Precious Metals or Population? The English Evidence By Anthony Edo; Jacques Melitz

  1. By: Horst, Maximilian; Neyer, Ulrike
    Abstract: In March 2015, the Eurosystem launched its QE-programme. The asset purchases induced a rapid and strong increase in excess reserves, implying a structural liquidity surplus in the euro area banking sector. Against this background, the first part of this paper analyses the Eurosystem's liquidity management during normal times, crisis times and times of too low in ation. With a focus on the latter, the second part of this paper develops a relatively simple theoretical model in which banks operate under a structural liquidity surplus. The model shows that increasing excess reserves have no or even a contractionary impact on bank loan supply. As the newly created excess reserves are heterogeneously distributed across euro area countries, the impact of QE on bank loan supply may differ across countries. Moreover, we derive implications for monetary policy implementation. Increases in the central bank's main refinancing rate as well as in the minimum reserve ratio and decreases in the central bank's deposit rate develop expansionary effects on loan supply - contrary to the case in which banks face a structural liquidity deficit.
    Keywords: monetary policy,quantitative easing (QE),monetary policy implementation,excess liquidity,loan supply,bank lending channel
    JEL: E43 E51 E52 E58 G21
    Date: 2019
  2. By: Bozhechkova Alexandra (Gaidar Institute for Economic Policy); Kiyutsevskaya Anna (RANEPA); Trunin Pavel (Gaidar Institute for Economic Policy); Knobel Alexander (Gaidar Institute for Economic Policy)
    Abstract: Russia’s central bank adopted a new monetary policy regime in 2018 by raising the key interest rate for the first time since December 2014. After slashing the key interest rate on February 9th and on March 23rd by 0.25 percentage points to 7.5 and 7.25 percent per annum, respectively, the central bank lifted the rate on September 14th by 0.25 percentage points to 7.5 percent per annum, with another hike on December 14th of 0.25 percentage points to 7.75 percent per annum. The transition to a neutral monetary policy regime2 slowed as far back as in 2017. There were more constraints to interest rate cuts in 2018 that came from new April and August anti-Russia sanctions that spurred capital outflows from the country and depreciation of the Russian ruble, a VAT hike decision scheduled for 2019, a late-year fall in energy prices, and concerns about possible heightening of inflation expectations. The key interest rate hike suggested that the Bank of Russia is committed to bring inflation back down to target in the medium term. For instance, according to a forecast of the central bank, end-of-year inflation for 2019 may reach 5–5.5 percent, and it is not until 2020 that inflation is back to its target.
    Keywords: Russian economy, monetary policy, money market, exchange rate, inflation, balance of payments
    JEL: E31 E43 E44 E51 E52 E58
    Date: 2019
  3. By: Florin Bilbiie (University of Lausanne)
    Abstract: An analytical (heterogeneous-agent New-Keynesian) HANK model allows a closed-form treatment of a wide range of NK topics: determinacy properties of interest-rate rules, resolving the forward guidance FG puzzle, amplification and fiscal multipliers, liquidity traps, and optimal monetary policy. The key channel shaping all the model's properties is that of cyclical inequality: whether the income of constrained agents moves less or more than proportionally with aggregate income. With countercyclical inequality, good news on aggregate demand gets compounded, making determinacy less likely and aggravating the FG puzzle (the resolution of which requires procyclical inequality)---a Catch-22, because countercyclical inequality is what HANK (and TANK) models need to deliver desirable amplification. The dilemma can be resolved if a distinct, "cyclical-risk" channel is procyclical enough. Even when both channels are countercyclical a Wicksellian rule of price-level targeting ensures determinacy and cures the puzzle. Optimal monetary policy is isomorphic to RANK and TANK but calls for less inflation stabilization. In a liquidity trap, even with countercyclical inequality and FG amplification, optimal policy does not imply larger FG duration because as FG power increases, so does its welfare cost.
    Date: 2019
  4. By: Bersson, Betsy; Hürtgen, Patrick; Paustian, Matthias
    Abstract: At the zero lower bound (ZLB), expectations about the future path of monetary or fiscal policy are crucial. We model expectations formation under level-k thinking, a form of bounded rationality introduced by García-Schmidt and Woodford (2019) and Farhi and Werning (2017), consistent with experimental evidence. This process does not lead to a number of puzzling features from rational expectations models, such as the forward guidance and the reversal puzzle, or implausible large fiscal multipliers. Optimal monetary policy at the ZLB under level-k thinking prescribes keeping the nominal rate lower for longer, but short-run macroeconomic stabilization is less powerful compared to rational expectations.
    Keywords: expectations formation,optimal monetary policy,New Keynesian model,zero lower bound,forward guidance puzzle,reversal puzzle,fiscal multiplier
    JEL: E32
    Date: 2019
  5. By: Francesco Bianchi; Leonardo Melosi; Matthias Rottner
    Abstract: Since the 2001 recession, average core inflation has been below the Federal Reserve’s 2% target. This deflationary bias is a predictable consequence of a low nominal interest rates environment in which the central bank follows a symmetric strategy to stabilize inflation. The deflationary bias increases if macroeconomic uncertainty rises or the natural real interest rate falls. An asymmetric rule according to which the central bank responds less aggressively to above-target inflation corrects the bias and allows inflation to converge to the central bank’s target. We show that adopting this asymmetric rule improves welfare and reduces the risk of self-fulfilling deflationary spirals. This approach does not entail any history dependence in setting the policy rate or any commitment to overshoot inflation after periods in which the lower bound constraint was binding.
    JEL: D84 E31 E51 E62 E63
    Date: 2019–09
  6. By: John Duffy (University of California, Irvine); Daniela Puzzello (Indiana University)
    Abstract: We explore the celebrated Friedman rule for optimal monetary policy in the context of a laboratory economy based on the Lagos-Wright model. The rule that Friedman proposed can be shown to be optimal in a wide variety of different monetary models, including the Lagos-Wright model. However, we are not aware of any prior empirical evidence evaluating the welfare consequences of the Friedman rule. We explore two implementations of the Friedman rule in the laboratory. The first is based on a deflationary monetary policy where the money supply contracts to offset time discounting. The second implementation pays interest on money removing the private marginal cost from holding money. We explore the welfare consequences of these two theoretically equivalent implementations of the Friedman Rule and compare results with two other policy regimes, a constant money supply regime and another regime advocated by Friedman, where the supply of money grows at a constant k-percent rate. We find that, counter to theory, the Friedman rule is not welfare improving, performing no better than a constant money regime. By one welfare measure, we find that the k-percent money growth rate regime performs best.
    Date: 2019
  7. By: Enrique Alberola (BIS); Carlos Urrutia (ITAM)
    Abstract: Informality is an entrenched structural trait in emerging market economies, despite of the progresses achieved in macroeconomic management. Informality determines the behavior of labour markets, financial access and the productivity of the overall economy. Therefore it influences the transmission of shocks and also of monetary policy. This paper develops a simple general equilibrium closed economy model with nominal rigidities, labor and financial frictions. Informality is captured by a dual labour market where the share of informal workers is endogenous. Only formal sector firms have access to financing, which is instrumental in their production process. Informality has a bu↵ering e↵ect on the propagation of demand and supply shocks to prices; the financial feature of the model boosts the impact of financial shocks in the formal sector while the informal sector is in principle unaffected. As a result informality dampens the impact of demand and financial shocks on wages and inflation but heighten the impact of technology shocks. Informality also increases the sacrifice ratio of monetary policy actions. From a Central Bank perspective, the results imply that the presence of an informal sector mitigates inflation volatility for some type of shocks but makes monetary policy less effective.
    Date: 2019
  8. By: Christian R. Proaño; Benjamin Lojak
    Abstract: In this paper we investigate the risk-related effects of monetary policy in normal times, as well as in periods where the zero lower bound (ZLB) binds, in a stylized macroeconomic model with boundedly rational beliefs. In our model, financial market participants use heuristics to assess the risk premium over the policy rate in accordance to an “implicit Taylor rule” that measures the stance of conventional monetary policy and which serves as an informative instrument during times when the funds rate is constrained by the ZLB. In such a case, conventional monetary policy is exhausted so that the central bank is forced to use unconventional types of policy. We propose alternative monetary policy measures to help the economy out of the liquidity trap which take into account this assumed form of bounded rationality.
    Keywords: Behavioral Macroeconomics, Monetary Policy, Zero Lower Bound, Bounded Rationality
    Date: 2019–09
  9. By: Athanasios Geromichalos (Department of Economics, University of California, Davis); Kuk Mo Jung (Department of Economics, Sogang University, Seoul); Seungduck Lee (Department of Economics, Sungkyunkwan University, Seoul, Republic of Korea); Dillon Carlos (Department of Economics, University of California, Davis)
    Abstract: Economists often say that certain types of assets, e.g., Treasury bonds, are very ‘liquid’. Do they mean that these assets are likely to serve as media of exchange or collateral (a definition ofliquidityoftenemployedinmonetarytheory), orthattheycanbeeasilysoldinasecondary market, if needed (a definition of liquidity closer to the one adopted in finance)? We develop a model where these two notions of asset liquidity coexist, and their relative importance is determined endogenously in general equilibrium: how likely agents are to visit a secondary market in order to sell assets for money depends on whether sellers of goods/services accept these assets as means of payment. But, also, the incentive of sellers to invest in a technology that allows them to recognize and accept assets as means of payment depends on the exis- tence (and efficiency) of a secondary market where buyers could liquidate assets for cash. The interaction between these two channels offers new insights regarding the determination of asset prices and the ability of assets to facilitate transactions and improve welfare.
    Keywords: Information, Over-the-Counter , Searchnd Matxhg, Liquidity, Asset prices, Monary policy
    JEL: E4 G11 G12 G14
    Date: 2019
  10. By: Seungduck Lee (Department of Economics, Sungkyunkwan University, Seoul, Republic of Korea); Kuk Mo Jung (Department of Economics, Sogang University, Seoul)
    Abstract: A new monetary theory is set out to resolve the “Uncovered Interest Parity (UIP)†Puzzle. It explores the possibility that liquidity properties of money and nominal bonds can account for the puzzle. A key concept in our model is that nominal bonds carry liquidity premia. We show that the UIP can fail to hold under the economic environment where collateral pledgeability and/or liquidity of nominal bonds and/or collateralized credit based transactions are relatively bigger. Our liquidity based theory can help understanding many empirical observations that risk based explanations find difficult to reconcile with.
    Keywords: uncovered interest parity puzzle, monetary search models, FOREX market
    JEL: E4 E31 E51 F31
    Date: 2019
  11. By: Tsutomu Watanabe (Graduate School of Economics, University of Tokyo); Tomoyoshi Yabu (Faculty of Business and Commerce, Keio University)
    Abstract: This paper estimates a money demand function using Japanese data from 1985 to 2017, which includes the period of near-zero interest rates over the last two decades. We compare a log-log specification and a semi-log specification by employing the methodology proposed by Kejriwal and Perron (2010) on cointegrating relationships with structural breaks. Our main finding is that there exists a cointegrating relationship with a single break between the money-income ratio and the interest rate in the case of the log-log form but not in the case of the semi-log form. More specifically, we show that the substantial increase in the money-income ratio during the period of near-zero interest rates is well captured by the log-log form but not by the semi-log form. We also show that the demand for money did not decline in 2006 when the Bank of Japan terminated quantitative easing and started to raise the policy rate, suggesting that there was an upward shift in the money demand schedule. Finally, we find that the welfare gain from moving from 2 percent inflation to price stability is 0.10 percent of nominal GDP, which is more than six times as large as the corresponding estimate for the United States.
    Keywords: money demand function; cointegration; structural breaks; zero lower bound; welfare cost of inflation; log-log form; semi-log form; interest elasticity of money demand
    JEL: C22 C52 E31 E41 E43 E52
    Date: 2019–09
  12. By: Leilane de Freitas Rocha Cambara; Roberto Meurer, Gilberto Tadeu Lima
    Abstract: The aim of this paper is to investigate whether inflation expectations in Brazil have characteristics and statistical properties that can be correlated (possibly in a causal way) with observed variables of interest and expectations about them. We test the hypothesis of perfect foresight in the formation of inflation expectations by the respondents of the official survey conducted by the Central Bank of Brazil, examining the behavior of the possible forecast errors. As these errors are biased and can be predicted, we reject the hypothesis of perfect foresight. We also test models of noisy and sticky information, and we cannot conclude that the deviations from perfect foresight can be explained by information rigidity. Additionally, with a Vector Error Correction model, we find evidence that the expectations about the related macroeconomic variables respond to each other as predicted by a theoretically-grounded macroeconomic model. Therefore, inflation expectations in Brazil are to an important extent consistent with more general expectations about the future performance of the economy.
    Keywords: Inflation expectations in Brazil; forecast errors in surveys; deviations from perfect foresight
    JEL: D84 E10 E31
    Date: 2019–09–20
  13. By: Kosuke Aoki (University of Tokyo); Hibiki Ichiue (Bank of Japan); Tatsushi Okuda (Bank of Japan)
    Abstract: Many developed economies in recent years have been characterized by a tight labor market and a low inflation environment, a phenomenon referred to as "missing inflation." To explain this phenomenon, we develop a dispersed information model in which consumers' search for cheaper prices affects firms' pricing behavior. The model shows that firms are reluctant to pass through cost increases because they fear a disproportionate decline in their sales. A history of low and stable inflation amplifies this effect by decreasing consumers' inflation beliefs. In this case, enhancement of the central bank's communication regarding its inflation target more firmly anchors consumers' inflation beliefs and makes the Phillips curve flatter, while enhancement of the central bank's communication about the current aggregate price level has the opposite effect.
    Keywords: missing inflation; imperfect information; price search; communication
    JEL: D82 E31 E58
    Date: 2019–09–20
  14. By: Òscar Jordà; Alan M. Taylor
    Abstract: Interest rates in major advanced economies have drifted down and in greater unison over the past few decades. A country’s rate of interest can be thought of as reflecting movements in the global neutral rate of interest, the domestic neutral rate, and the stance of monetary policy. Only the latter is controlled by the central bank. Estimates from a state space New Keynesian model show that central bank policy explains less than half of the variation in interest rates. The rest of the time, the central bank is catching up to trends dictated by productivity growth, demography, and other factors outside of its control.
    JEL: E43 E44 E52 E58 F36 N10
    Date: 2019–09
  15. By: Philippe Bacchetta; Eric van Wincoop
    Abstract: The objective of this paper is to show that the proposal by Froot and Thaler (1990) of delayed portfolio adjustment can account for a broad set of puzzles about the relationship between interest rates and exchange rates. The puzzles include: i) the delayed overshooting puzzle; ii) the forward discount puzzle (or Fama puzzle); iii) the predictability reversal puzzle; iv) the Engel puzzle (high interest rate currencies are stronger than implied by UIP); v) the forward guidance exchange rate puzzle; vi) the absence of a forward discount puzzle with long-term bonds. These results are derived analytically in a simple two-country model with portfolio adjustment costs. Quantitatively, this approach can match all targeted moments related to these puzzles.
    JEL: F3 F31 F41 G11 G12
    Date: 2019–09
  16. By: Athanasios Geromichalos (Department of Economics, University of California, Davis); Kuk Mo Jung (Department of Economics, Sogang University, Seoul)
    Abstract: We develop a monetary model that incorporates Over-the-Counter (OTC) asset trade. After agents have made their money holding decisions, they receive an idiosyncratic shock that affects their valuation for consumption and, hence, for the unique liquid asset, namely, money. Subse- quently, agents can choose whether they want to enter the OTC market in order to sell assets and, thus, boost their liquidity, or to buy assets and, thus, provide liquidity to other agents. In our model inflation affects not only the money holding decisions of agents, as is standard in monetary theory, but also the entry decision of these agents in the financial market. We use our framework to study the effect of inflation on welfare, asset prices, and OTC trade volume. In contrast to most monetary models, which predict a negative relationship between inflation and welfare, we find that inflation can be welfare improving within a certain range, because it mitigates a search externality that agents impose on one another when they make their OTC market entry decision. Also, an increase in the holding cost of money will lead to a decrease in asset prices, a regularity which is well-documented in the data and often considered anomalous.
    Keywords: monetary-search models, liquidity, asset prices, over-the-counter markets
    JEL: E31 E50 E52 G12
    Date: 2019
  17. By: Guillermo A. Calvo
    Abstract: The paper discusses simple microfoundations for Liquidity Deflation (Calvo 2016, Chapter 2), which gives rise to liquidity trap under perfectly flexible prices/wages. Unlike Keynes (1936), this is a Supply Side Liquidity Trap, SSLT, not resolved by a fall in prices /wages, or massive helicopter increase in liquid government liabilities. However, escaping SSLT could be achieved by low policy interest rates on money (unless ZLB holds) and, more interestingly, higher inflation driven by administered prices/wages. Moreover, contrary to (Friedman 1969), under Liquidity Deflation the Optimal Quantity of Money does not call for liquidity satiation, and may be dangerously close to SSLT.
    JEL: E31 E4 E41 E5 E52
    Date: 2019–09
  18. By: Emile van Ommeren; Giulia Piccillo
    Abstract: This paper examines the role of central bank governors in monetary policy decisions taken by a committee. To carry out this analysis, we constructed a novel dataset of committee voting behaviour for six OECD countries for up to three decades. Using a range of Taylor-rule specifications, we show that a change in governor significantly affects the interest rate setting of the whole committee. We also observe systematic differences in the responsiveness to recent changes in the state of the economy based on the political party appointing the governor, with higher responsiveness under governors that are appointed by a left-wing political authority. In contrast, right wing appointed governors are more likely to consider expected economic developments in the future when deciding on the appropriate interest rate.
    Keywords: monetary policy, Taylor rule, central bank governors
    JEL: E00
    Date: 2019
  19. By: Sophie van Huellen (Department of Economics, SOAS University of London, UK); Duo Qin (Department of Economics, SOAS University of London, UK); Shan Lu (School of Economics and Management, Beihang University, China PR.); Huiwen Wang (School of Economics and Management, Beihang University, China PR.); Qingchao Wang (Department of Economics, SOAS University of London, UK); Thanos Moraitis (Department of Economics, SOAS University of London, UK)
    Abstract: We apply a novel model-based approach to constructing composite international financial indices (CIFIs) as measures of opportunity cost effects that arise due to openness in money demand models. These indices are tested on the People’s Republic of China (PRC) and Taiwan Province of China (TPC), two economies which differ substantially in size and degree of financial openness. Results show that a) stable money demand equations can be identified if accounting for foreign opportunity costs through CIFIs, b) the monetary policy intervention in the PRC over the global financial crisis period temporarily mitigated disequilibrating foreign shocks to money demand, c) CIFIs capture opportunity costs due to openness more adequately than commonly used US interest rates and d) CIFI construction provides valuable insights into the channels through which foreign financial markets affect domestic money demand.
    Keywords: money demand, opportunity cost, open economy
    JEL: E41 F41 C22 O53
    Date: 2019–08
  20. By: Maurício S. Bugarin; Fabia A. de Carvalho
    Abstract: This paper analyzes a signaling model of monetary policy when inflation targets are not set by the monetary authority. The most important implication of the model’s solution is that a higher ex-ante dispersion in central bankers’ preferences, referred to as heterogeneity in policy orientation, increases the signaling cost of commitment to inflation targets. The model allows for a comparison of two distinct institutional arrangements regarding the tenure in office of the central banker and the head of government. We find that staggered terms yield superior equilibria when opportunistic political business cycles can arise from presidential elections. This is a consequence of a reduction of information asymmetry about monetary policy and gives theoretic support to the observed practice of staggered terms among independent central banks
    Date: 2019–09
  21. By: James Bullard (Federal Reserve Bank of St. Louis); Riccardo DiCecio (Federal Reserve Bank of St. Louis)
    Abstract: We study nominal GDP targeting as optimal monetary policy in a simple and stylized model with a credit market friction. The macroeconomy we study has considerable income inequality, which gives rise to a large private sector credit market. There is an important credit market friction because households participating in the credit market use non-state contingent nominal contracts (NSCNC). We extend previous results in this model by allowing for substantial intra-cohort heterogeneity. The heterogeneity is substantial enough that we can approach measured Gini coefficients for income, financial wealth, and consumption in the U.S. data. We show that nominal GDP targeting continues to characterize optimal monetary policy in this setting. Optimal monetary policy repairs the distortion caused by the credit market friction and so leaves heterogeneous households supplying their desired amount of labor, a type of "divine coincidence" result. We also further characterize monetary policy in terms of nominal interest rate adjustment.
    Date: 2019
  22. By: Victor Dorofeenko; Gabriel Lee; Kevin Salyer; Johannes Strobel
    Abstract: This paper demonstrates that risk (uncertainty) along with the monetary (interest rates) shocks to thehousing production sector that is subject to nominal frictions in prices and wages are a quantitativelyimportant impulse mechanism for the business and housing cycles. Our model framework is that ofthe housing supply/banking/monetary sector model as developed in Dorofeenko, Lee, Salyer and Strobel(2016) with the model of housing demand with sticky pricing (Calvo) presented in Iacoviello and Neri(2010). We provide empirical evidence that large housing price and residential investment boom and bustcycles over the last few years are driven largely by economic fundamentals and financial constraints. Wefind the impact of risk and monetary shocks are the main impulse in explaining the aggregate and sectoralfluctuations. Moreover, in the presence of nominal frictions in prices and wages, the Loan to Value ratiothat affects the household borrowing constraint plays a critical role for real aggregate variables. Thiscomparison carries over to housing market variables such as the price of housing, the risk premium onloans, and the bankruptcy rate of housing producers.
    Keywords: credit constraint; hetrogenous households; Monetary Policy; residential investment; uncertainty and demand shocks
    JEL: R3
    Date: 2019–01–01
  23. By: Perekunah B. Eregha (Pan-Atlantic University, Lekki-Lagos. Nigeria); Arcade Ndoricimpa (University of Burundi, Burundi)
    Abstract: The study applies a BEKK GARCH-M model to examine the effect of uncertainty on the levels of inflation and output growth in Nigeria. The results suggest a significant positive effect of inflation uncertainty on the level of inflation, supporting the Cukierman and Meltzer (1986) hypothesis. In addition, uncertainty about inflation is found to be detrimental to output growth, supporting the Friedman’s (1977) hypothesis of a negative effect of inflation uncertainty on output growth. Uncertainty about growth does not have a significant effect on both the levels of inflation and output growth. The evidence in this study suggests that Nigeria should put in place policies minimizing inflation uncertainty to avoid its adverse effects on the economy. In addition, the independence relationship between output growth and its uncertainty in Nigeria suggest that they can be treated separately as suggested by business cycle models.
    Keywords: Inflation, Inflation Uncertainty, Output, Output Uncertainty, BEKK GARCH-M
    JEL: C22 E0
    Date: 2019–01
  24. By: Oscar Jorda (Federal Reserve Bank of San Francisco an); Alan Taylor (University of California, Davis); Sanjay Singh (University of California, Davis)
    Abstract: A well-worn tenet holds that monetary policy does not affect the long-run productive capacity of the economy. Merging data from two new international historical databases, we find this not to be quite right. Using the trilemma of international finance, we find that exogenous variation in monetary policy affects capital accumulation, and to a lesser extent, total factor productivity, thereby impacting output for a much longer period of time than is customarily assumed. We build a quantitative medium- scale DSGE model with endogenous TFP growth to understand the mechanisms at work. Following a monetary shock, lower output temporarily slows down TFP growth. Internal propagation of the monetary shock extends the slow down in productivity, and eventually lowers trend output. Yet the model replicates conventional textbook results in other dimensions. Monetary policy can have long-run effects.
    Date: 2019
  25. By: Troy D Matheson
    Abstract: Against the backdrop of an ongoing review of the inflation-targeting framework, this paper examines the real-time inflation forecasts of the Bank of Canada with the aim of identifying potential areas for improvement. Not surprisingly, the results show that errors in forecasting non-core inflation (commodity prices etc.) are found to be the largest contributors to overall inflation forecast errors. Perhaps more importantly, relatively small core inflation forecast errors appear to mask large and offsetting errors related to the output gap and the policy interest rate, partly reflecting a tendency to overestimate the neutral nominal policy rate in real time. Faced with these uncertainties, the Governing Council’s gradual approach to changing its policy settings appears to have served it well.
    Date: 2019–09–13
  26. By: Massimo Guidolin; Manuela Pedio
    Abstract: We investigate the effects of a conventional monetary expansion, the quantitative easing, and maturity extension programs on the yields of corporate bonds. We adopt a multiple-regime VAR identification based on heteroskedasticity. An impulse response function analysis shows that a traditional, rate based expansionary policy leads to an increase in yields. The response to quantitative easing is instead a general and persistent decrease, in particular for long-term bonds. The responses generated by the maturity extension program are significant and of larger magnitude. A decomposition shows that the unconventional programs reduce the cost private debt primarily through a reduction in risk premia.
    Keywords: unconventional monetary policy; transmission channels; heteroskedasticity; vector autoregressions; identification; corporate bond yields.
    JEL: G12 C32 G14
    Date: 2019
  27. By: Belinda Cheung (Reserve Bank of Australia); Sebastien Printant (Reserve Bank of Australia)
    Abstract: In recent years, the spread between money market interest rates has widened. One implication is that the price of Australian dollars diverges across these markets. Even after risks associated with creditworthiness, liquidity and other factors have been taken into account, it appears that unexploited arbitrage opportunities persist. Typically the literature only assesses the profitability of arbitrage by calculating the return from funding at low money market rates to invest at higher rates. However, banks have broader balance sheet considerations that need to be taken into account. We therefore take a 'whole-of-balance-sheet' approach to assessing the potential for arbitrage opportunities available to the four major banks in Australia. this takes into consideration that banks optimise their balance sheet not only by funding themselves at the lowest possible rates to maximise profitability, but also for compliance with prudential regulation, maintenance of capital adequacy, and opportunity cost in asset allocation. We find that once asset-specific funding costs are taken into account, short-term money market trades would have generally not been profitable for the major banks. Overall, the incentive for banks to arbitrage has fallen since 2008. Our result reflects both a rise in the cost of debt funding relative to market returns and an increase in the share of equity funding. We also note that the deployment of balance sheet space to money market trading incurs a significant opportunity cost, when compared to lending for residential housing. Not surprisingly, the balance sheets of the major banks are therefore skewed toward more profitable lending activities, rather than money market trading.
    Keywords: arbitrage; banks; funding costs; money markets
    JEL: G10 G11 G18 G21
    Date: 2019–09
  28. By: Tsutomu Watanabe (Graduate School of Economics, University of Tokyo); Tomoyoshi Yabu (Faculty of Business and Commerce, Keio University)
    Abstract: This paper estimates a money demand function using Japanese data from 1985 to 2017, which includes the period of near-zero interest rates over the last two decades. We compare a log-log specification and a semi-log specification by employing the methodology proposed by Kejriwal and Perron (2010) on cointegrating relationships with structural breaks. Our main finding is that there exists a cointegrating relationship with a single break between the money-income ratio and the interest rate in the case of the log-log form but not in the case of the semi-log form. More specifically, we show that the substantial increase in the money-income ratio during the period of near-zero interest rates is well captured by the log-log form but not by the semi-log form. We also show that the demand for money did not decline in 2006 when the Bank of Japan terminated quantitative easing and started to raise the policy rate, suggesting that there was an upward shift in the money demand schedule. Finally, we find that the welfare gain from moving from 2 percent in ation to price stability is 0.10 percent of nominal GDP, which is more than six times as large as the corresponding estimate for the United States.
    Date: 2019–09
  29. By: Xing Guo (University of Michigan); Pablo Ottonello (University of Michigan); Toni Whited (University of Michigan)
    Abstract: We study the transmission of monetary policy though firms' equity financing. At the aggregate level, we document that firms respond to monetary expansions by increasing equity issuance, and that the response of equity flows is quantitatively more important than that of debt flows. At the micro level, we show that monetary stimulus significantly mitigates the stock price drop associated equity issuance, suggesting a reduction in the asymmetric information premium in equity markets. Motivated by this evidence, we construct a corporate finance model of equity financing under asymmetric information that can rationalize these findings. We use the model to study its aggregate implications. Monetary policy affects the composition of investment, by making firms with high productivity projects more willing to use external finance. If the arrival rate of investment opportunities is given, this means that monetary stimulus can contain the seeds of a subsequent productivity slowdown.
    Date: 2019
  30. By: Peter Hördahl; Oreste Tristani
    Abstract: We propose a regime-switching approach to deal with the lower bound on nominal interest rates in dynamic term structure modelling. In the "lower bound regime", the short term rate is expected to remain constant at levels close to the effective lower bound; in the "normal regime", the short rate interacts with other economic variables in a standard way. State-dependent regime switching probabilities ensure that the likelihood of being in the lower bound regime increases as short rates fall closer to zero. A key advantage of this approach is to capture the gradualism of the monetary policy normalization process following a lower bound episode. The possibility to return to the lower bound regime continues exerting an influence in the early phases of normalization, pulling expected future rates downwards. We apply our model to U.S. data and show that it captures key properties of yields at the lower bound. In spite of its heavier parameterization, the regime-switching model displays a competitive out-of-sample forecasting performance. It can also be used to gauge the risk of a return to the lower bound regime in the future. As of mid-2018, it provides a more benign assessment than alternative measures.
    Keywords: zero lower bound, term premia, term structure of interest rates, monetary policy rate expectations, regime switches
    JEL: E31 E40 E44 E52 E58 E62 E63
    Date: 2019–09
  31. By: Adam, Klaus; Weber, Henning
    Abstract: We document a new stylized fact for the life-cycle behavior of consumer prices: relative to a narrowly defined set of competing products, the price of individual products tends to fall over the product lifetime. This holds true for more than 90% of the expenditure items underlying the U.K. consumer price index and has important normative implications. Constructing a sticky price model featuring a product life cycle and rich amounts of heterogeneity, we explain how the optimal in ation target can be estimated from the observed trends in relative prices. The optimal inflation target for the U.K. is found to range between 2.6% and 3.2% and to have steadily increased over the period 1996 to 2016. We show how changes in relative price trends contributed to this development.
    Keywords: Optimal Inflation Rate,Product Life Cycle,U.K. Micro Price Data
    JEL: E31
    Date: 2019
  32. By: Anthony Edo (CEPII.); Jacques Melitz (CREST; CEPII.)
    Abstract: We perform the first econometric test to date of the influences of inflows of precious metals and population growth on the “Great Inflation” in Europe following the discovery of the New World. The English evidence strongly supports the near-equivalent importance of both influences. For 1500-1700, silver is the only relevant precious metal in the estimates. The study controls for urbanization, government spending, mortality crises and climatic changes. The series for inflows of the precious metals into Europe from America and European mining are newly constructed based on the secondary sources.
    Keywords: The Great Inflation, Demography, Precious metals, European economic history 1500-1700
    JEL: E31 F00 J10 N13 N33
    Date: 2019–09–01

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